The Victoria Falls Stock Exchange (VFEX) recently announced the approval by the Securities Exchange Commission of Zimbabwe (SECZim) of the rules for Contracts for Differences (CFDs). The exchange has once again moved to bring another product closer to launch as they look to increase activity on Zimbabwe’s US Dollar denominated exchange. While many news outlets reported the move, we asked a deeper question; what do the rules say? Thanks to the team at the VFEX, we got our hands on the rules and were able to pick through some highlights.
Contracts for Differences (CFDs)
Firstly let’s define the kind of animal that a Contract for Difference is. A CFD is a contract between an investor and a financial institution. In this contract, the investor takes a position on the expected movement in an underlying asset. The difference between the asset value at the contract’s opening and the contract’s closing is settled in cash. CFDs offer the opportunity to profit from the movement of an asset without taking ownership of the asset. However, there is a risk to the investor if the price movement is adverse to their position. In this case, they lose their margin payments (the cost of establishing the contract). CFDs are used in many markets, including equities, commodities and foreign currency trading.
VFEX CFD rules highlights
We can pick a few highlights from the 47-page CFD rules for the VFEX document.
VFEX listed underlying assets
Where the underlying asset for a CFD is VFEX listed, it must have an average market capitalisation (total market value in market) of USD3 million in the last 3 months or USD5 million if it has been trading for less than 3 months. At present, all VFEX-listed equities satisfy the requirement.
Non-VFEX-listed underlying assets
More interestingly, the CFD rules allow for underlying assets that are not VFEX listed, provided they are listed on an exchange that has signed the International Organization of Securities Commission’s multilateral memorandum of understanding (IOSCO MMoU). The same market capitalisation rules apply to VFEX-listed underlying assets. This opens the door for ZSE-listed counters CFDs if currency stability allows.
The VFEX will also allow CFDs on indices provided the indices are securities exchange listed in a similar manner to non-VFEX listed underlying assets. The Underlying Index must also have a transparent composition that can be easily accessed.
Underlying Currency Pairs
The Press statement from the VFEX specifically mentioned foreign currency trading as a use case for CFDs. Currency pairs have been accommodated in the rules. For a currency pair CFD, major international banks must quote the currency pair, which pretty much excludes the Zimbabwean dollar from currency CFDs. In addition, there should be no trading restriction on the currency pair. These rules are clearly to aid with transparency in the underlying currency pair.
In CFDs, the payments made to establish and maintain the contract are known as margins. We have seen these before in our discussions on options and futures. The VFEX CFD rules allow a minimum margin, with brokers allowed to charge more. The table above, extracted from the VFEX CFD rules, shows the minimum margins as 10% for single shares in an index, 20% for single non-index shares, 5% for index CFDs and 1% for currency pair CFDs. In simple terms, the payment one would make to establish a currency pair CFD is 1% of the value at risk in the CFD.
The third column of the table above shows us that leverage has been permitted for VFEX CFDs. Leverage is a process where a broker essentially lends money to an investor to amplify the potential of their CFD. Single shares that are index-listed will get 1:10 maximum leverage. Non-index single share CFDs are allowed maximum 1:5 leverage. Index CFDs are allowed a maximum leverage of 1:20, while currency pair CFDs are permitted maximum leverage of 1:100. This means in a currency CFD worth $1, the broker can lend an investor $100 to boost their trade. This comes at a cost but can amplify returns 100-fold.
Stop loss necessary
Brokers must ensure a stop-loss mechanism is available on their CFD offerings. A stop loss is an automatic mechanism which immediately closes a position when the underlying asset price drops to a level nominated by the investor. Say you take a CFD position that Asset X will rise from its current 100 to 110. If your risk tolerance is 5% loss, you will then set a stop loss at 95. If, at any time, while the CFD is active, the price drops to 95 or below, the broker automatically closes the position to limit your losses.
The VFEX CFD rules make no mention of a take-profit mechanism, but it works in the same way as a stop-loss but in the opposite direction. So in our example, I can set a take profit at 111 to automatically close the position and take profit if, at any time, while the CFD is active, Asset X price rises to 111 or higher. The two usually come together, so even though the VFEX CFD rules are silent on take-profit, we should expect to see them too.
Cash settlement only
As mentioned before, CFDs do not settle with underlying assets but only on the difference in the open and closing price in cash.
No voting rights to underlying shares
Since CFDs do not involve the investor holding the underlying asset, no voting rights (where the underlying assets have them) will pass to the investor.
CFD Broker requirements
Brokers will need to be Licensed by the Securities Exchange Commission of Zimbabwe (SECZim) and a VFEX member broker to offer VFEX CFDs. Presently the VFEX has 15 securities dealers that meet both these requirements.
White label allowed
The VFEX has opened a pathway for international brokers to partner with local brokers through white-label agreements. A white label agreement is a term from manufacturing that allows someone to brand and sell products manufactured by someone else and sell them. So international brokers can offer their services through a local broker, but it must be clear to investors that the arrangement is white-label.
Online accounts allowed
As we know, VFEX recently went online with VFEX direct. The CFD rules allow for online accounts, which brings the VFEX CFDs fully up to speed with other international CFD markets, which are fully accessible online. KYC requirements will apply to users.
CFD Advertisement and marketing materials
There are a few requirements set out for advertising and marketing materials. Brokers are required to have written warnings in all advertising and marketing material of the risk of loss when trading CFDs. They must also clearly explain that CFDs do not entitle investors to ownership or associated rights in underlying assets. All materials must be clear and not contain any confusing language or hedge clauses.
No hedge clauses
A hedge is a disclaimer you may be familiar with seeing in research reports that indemnify the report writer from any loss due to inaccuracy or omission in the information. Such disclaimers must not be contained in VFEX CFD marketing material and will not apply to information supplied within the material.
Finally, Brokers will be required to provide various data on CFDs via a monthly report to the VFEX.
It’s a lot to digest, but we have an idea of what CFD trading will look like via the VFEX. You can get a copy of the VFEX CFD rules by emailing firstname.lastname@example.org or downloading them from the VFEX website.